The world’s commodity currencies—Australian, New Zealand and Canadian dollar—should continue to perform well against the US dollar next year despite a strong run during 2010, say strategists at Citi.
At present the Australian and Canadian dollars are trading almost at par against their US counterpart, while the Kiwi dollar has recently strengthened again to reach NZ$1/US$0.75. Despite a fallback since QE2 they have all performed strongly on average over the year.
There is a feeling that commodity currencies are looking overvalued. This is down to the sense that their appreciation is outpacing movement in the commodity terms of trade—how much is exported per import.
Citi believes that capital flows are being directed those currencies’ way as a result of very loose monetary policy in the US, and that this has not been factored into this line of argument.
“If currency appreciation is outrunning underlying moves in commodity prices, it stands to reason that the potential boost from increases in exports could prove more moderate than expected... this line of thinking greatly overemphasises the impact from trade flows and underemphasises that from capital flows,” Todd Elmer, strategist for Citi in Singapore said.
To back this line of reasoning up he noted that correlation between moves in commodity currencies currencies and global asset prices is strengthening.
“During periods of rising risk appetite and gaining asset prices, the commodity currencies tend to benefit from inflows. The fact that A$, CAD, and NZ$ have appreciated by more than other ‘risky’ currencies suggests they are the most attractive alternative to US dollar,” Elmer said, arguing this is unlikely to change for a few quarters to come.
Citi also notes that policymakers in the three countries will struggle to come to terms with the impact of capital flows despite the fact they don’t want to see their respective currencies strengthen too much. With this in mind, it seems that interest rates may creep up but the countries should still see the currency appreciate.
However none of this will be a complete surprise to the market. IMM data (which takes into account non-commercial and speculative FX positioning) already is showing large long positions being formed in commodity currencies which, since July, have accounted for around 50% of total positions being made.
One risk is that this is far outweighing these currencies share of global capital markets and turnover. “This likely means there is risk for temporary pullback as positions are flushed out upon bouts of risk aversion. Still we doubt this would mark a change in trend,” Elmer said.